Consumer lending in China

Safe as houses?

Another big problem looms for China's rickety banks

CHINA'S banks have been scrubbing hard, hoping to make themselves clean enough to attract foreign capital. If you believe official figures, their non-performing loan (NPL) ratio fell to 13.2% at the end of last year, from nearly 18% in 2003. None has scrubbed harder than the two big state banks being groomed for strategic investment and flotation: Bank of China (BoC) said last month that its NPL ratio was just 4.7%, and China Construction Bank (CCB) claims 3.7%. Independent data are also looking less gloomy. Standard & Poor's, a credit-rating agency, reckons 35% of loans will go sour, down from its previous estimate of 50%. This may help win round foreign banks, which have so far resisted taking stakes. Royal Bank of Scotland is said to be ready to pay up to $4 billion for up to a fifth of BoC, although the Edinburgh bank would not be drawn at its annual meeting on April 20th. There are also rumours that foreigners are preparing to buy a stake in CCB.

The banks' old bad debts are worrying enough. But potential investors should probably be more concerned about what has yet to appear in the books. Between the start of 2001 and early 2004, China went on an almighty credit binge. Bank lending jumped by 56% in 2003 alone, as the government first tried to shore up growth and then lost control of a racing economy before trying to rein it in last spring. At the state's behest, banks lent enormous sums for new factories, roads and airports, many of which will never make money.

However, for the first time they also lent hand-over-fist to individuals, deluging them with credit cards, mortgages and car loans in an attempt to make growth more balanced by encouraging consumer spending. A tenth of all outstanding bank loans, or around 2 trillion yuan ($242 billion), is now owed by consumers. Mortgages, which account for 90% of this, grew at an annual compound rate of 115% between 1998 and 2004, according to KGI, a securities firm. Last year, they rose by 38%, against just 6% for corporate loans (see chart). Banks have been delighted to grant home loans because they carry only a 50% weighting in the calculation of risk-weighted assets—a tribute to the perceived safety of mortgages.

That may be a dangerous misperception. Last June, the National Audit Office warned of widespread consumer-credit problems, citing one borrower who was lent enough in multiple mortgages to buy 128 apartments. China lacks a national consumer-credit database to spot overstretched debtors, although a pilot system linking seven cities was set up late last year. Never having seen a complete mortgage-credit cycle, Chinese banks appear not to understand the downside risks. And they have few channels to lay off risk: the central government has repeatedly stalled moves to securitise consumer loans.

For now, the economy is accelerating: it grew by an unexpectedly fast 9.5% in the first quarter, according to figures published this week. That means default rates are low: 2-3% for mortgages, says KGI's Chuan Tang. But it may also herald a harder official crackdown on a frothy housing market. Last month the authorities introduced a capital-gains tax on property in Shanghai and forced banks to raise mortgage rates. Interest rates are likely to go up again, leading to an increase in bad debts. KGI estimates that a rise of just one percentage point in mortgage NPLs would knock 11.4% off the earnings of Shanghai Pudong Development Bank, 9% off China Minsheng Bank and 7% off China Merchants Bank. And these listed banks are in better shape than their bigger unlisted cousins.

The car-loan business shows what can happen when the state applies the brakes. Thousands who borrowed to buy cars in the past three years simply stopped paying after the government tightened credit. Without proper records, it has been impossible to trace defaulters, even if they gave correct information in the first place. Volkswagen, the leading carmaker in China, puts the default rate on loans in Beijing at 5%, ten times that in Europe. Other reports suggest that 95 billion yuan of banks' car loans, or 50%, are overdue. More than 30 billion yuan is owed to Agricultural Bank of China, the weakest of the four big state lenders. Most foreign firms investing in China see the Chinese consumer as the answer to their prayers. The world's banks might want to think otherwise.